accounting for pension plans - cengage … · accounting for pension plans learning objective...

ACCOUNTING FOR PENSION PLANS

L E A R N I N G O B J E C T I V E

Understand the required disclosures for pension plans and analyze changes in the assets and liabil-ities of a pension plan during a period.

Chapter 10 sets forth the guiding principle for recognizing the cost of pension and other retirement benefits foremployees: firms should recognize the future cost of retirement benefits as an expense during employees’ work-ing years to match the expenses for retirement benefits with the revenues generated by employees’ services.

Measuring pension expense during employees’ working years requires estimates of the following:

1. The number of years employees will work before retirement (all else being equal, the more time untilretirement, the lower is current pension expense)

2. The salary levels that employees will achieve and that serve as the basis for calculating pension benefits(the higher those salaries, the larger is current pension expense)

3. The employee turnover rate, which will affect the number of employees who will receive pension bene-fits (the higher the turnover, the lower is current pension expense)

4. The rate of return that pension fund assets will generate between the time the employer contributes cashto a fund and the time the fund pays benefits to employees (the higher the rate, the lower is current pen-sion expense)

5. The number of years employees will receive pension benefits during retirement (the larger the number,the larger is current pension expense)

The need to make these estimates injects uncertainty into the measurement of an employer’s obligation forpension benefits and the amount of funds the employer must set aside to ensure adequate funding of its obliga-tion. Collectively, these assumptions are the actuarial assumptions of the plan. The Financial AccountingStandards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 87 requires firms to disclosecertain information about their pension plans to enable users of financial statements to assess the performance ofa pension fund during a period and the financial condition of the pension plan at the end of the period.

A S S E T S A N D L I A B I L I T I E S O F A P E N S I O N P L A N

A pension plan keeps its own set of books, separate from the accounting records of the employer. The pensionplan has assets in the form of cash and various investments. Cash contributions from the employer and earn-ings generated from pension investments provide the assets for the pension plan. The pension plan also hasliabilities, equal to the present value of amounts the pension plan must pay to employees during retirement.The assets in a pension plan may exceed its liabilities, in which case the plan is overfunded. The liabilitiesof a pension plan may exceed its assets, in which case the plan is underfunded.

Pension Plan Assets The pension plan receives cash each period from the employer. The planinvests this cash in bonds, capital stock, real estate, and other investments to generate income. The planpays cash to retired employees each period. The pension plan assets change each period as follows:

Assets at Beginning of Period

+/– Actual Earnings on Pension Plan Investments

+ Contributions Received from the Employer

– Payments to Retirees

= Assets at End of Period

SFAS No. 87 requires firms to report pension plan assets at their market values. Thus, actual earnings frompension plan investments include both realized amounts (interest, dividends, capital gains and losses) andunrealized amounts (changes in the market values of investments held).

Pension Plan Liabilities The pension plan computes the amount of its pension plan liabilitieseach period. The liability of a defined contribution plan equals the assets in the pension fund. The computa-tion of the pension liability for a defined benefit plan uses the pension benefit formula underlying the pen-sion plan and depends on assumptions about employee turnover, mortality, interest rates, and other factors.The liability of the pension plan equals the present value of the expected amounts payable to employees.

The typical benefit formula takes into account the employee’s length of service and some measure of aver-age earnings. For example, the employer might promise to pay each employee during retirement an annualpension equal to a stated percentage of the average annual salary during the five highest-paid working yearsfor that employee. The percentage might increase by 2 percentage points for each year of service, so that anemployee with 40 years of service could receive an annual pension equal to 80 percent of that employee’saverage salary during the five highest-paid working years.

SFAS No. 87 defines two measures of the pension liability of the pension plan:

1. Accumulated benefit obligation—the present value of amounts the plan expects to pay to employeesduring retirement based on accumulated service and current salary at the time of measuring the pensionliability

2. Projected benefit obligation—the present value of amounts the plans expects to pay to employees dur-ing retirement based on accumulated service to date but using the level of salary expected to serve as abasis for computing pension benefits; the difference between the accumulated benefit obligation and theprojected benefit obligation relates to future salary increases.

SFAS No. 87 requires firms to disclose both measures of the pension obligation. Firms must use the pro-jected benefit obligation in measuring pension expense each period (discussed later). If the accumulatedbenefit obligation exceeds the assets in the pension fund, the firm must report the underfunded accumulatedbenefit obligation on its balance sheet as a liability.

The liability of the pension plan changes each period as follows:

Projected Benefit Obligation (PBO) at Beginning of Period

+ Increase in PBO for Interest

+ Increase in PBO for Current Employee Service

– Payments to Retirees

+/– Actuarial Gains and Losses

= Projected Benefit Obligation at End of Period

The projected benefit obligation changes for several reasons:

■ Like other long-term liabilities, it increases each period because interest accumulates as the paymentdate approaches.

■ It increases because employees work another period and earn rights to a larger pension.

■ It changes because the pension plan changes actuarial assumptions about employee turnover, mortal-ity, interest (discount) rates, and similar factors.

M E A S U R E M E N T O F E M P L O Y E R ’ S P E N S I O N E X P E N S E

Pension expense for a defined contribution plan equals the amount contributed to the pension fund. Pensionexpense for a defined benefit plan comprises the following:

A c c o u n t i n g f o r P e n s i o n P l a n s 2

Interest Cost (the increase in PBO because time passes)

+ Service Cost (the increase in PBO because employees work an additional year)

– Expected Return on Pension Investments

+/– Amortization of Actuarial and Performance Gains and Losses

= Net Pension Expense

The interest cost and the service cost of a pension plan represent projected benefit obligation increases, forthe period, that the pension plan must eventually pay. A portion of the funds needed to pay the increasedprojected benefit obligation comes from income from pension investments. The return from these investmentsreduces pension expense because it reduces the amount the employer must contribute. Recall from the dis-cussion in the text that total expense must equal total cash outflow. Because earnings on pension invest-ments reduce the cash outflow the employer must contribute to the pension plan, the return on pensioninvestments reduces pension expense. Firms typically disaggregate the expected return on pension invest-ments into two lines: (1) the actual return on pension investments during the period and (2) the differencebetween actual return and expected return on pension assets. This presentation provides information forassessing the performance of the pension fund during the period but does not recognize excess or deficientreturns in measuring pension expense immediately.

The actual return from pension investments may exceed or fall short of the expected return. Likewise,the projected benefit obligation may change because actuarial assumptions have changed and because firmsimprove, or sweeten, pension benefits and give employees retroactive credit under the new benefit formula forprior years of service. SFAS No. 87 requires firms to smooth the effect that these items have on pensionexpense by amortizing them over some period of years. Amortization of these amounts represents the fourthcomponent of pension expense.

P E N S I O N F U N D D I S C L O S U R E S

Exhibit 1 shows typical pension fund disclosures for General Products Company at the end of Year 5 in accor-dance with SFAS No. 87. The notes to this exhibit elaborate on these disclosures. Observe the following:

1. The expected return on pension fund investments for Year 5 was $1,067 million, which reduces pen-sion expense. Firms disclose this expected return on two lines: actual return on plan assets ($2,739 mil-lion) plus or minus the difference between the actual return and the expected return ($1,672 million). Thisdisclosure informs the financial statement user that pension investments during Year 5 (and Year 4)earned a higher rate of return than expected. One can interpret this excess in several ways. A continualpattern of excess return may permit the employer to reduce contributions in the future. Alternatively,actual returns in the future may fall below the expected level, and this will offset the excess returns inYear 4 and Year 5. The pension plan will thereby achieve its long-run, expected return. Because SFASNo. 87 requires the valuation of pension assets at market values instead of acquisition cost, a portion ofthe actual return each period represents unrealized gains and losses from changes in market values.

2. The assets in the pension plan at the end of Year 5 of $15,747 million exceed the accumulated benefitobligation of $12,258 million. Thus, SFAS No. 87 does not require General Products Company to reporta liability on the balance sheet. The assets in the pension fund also exceed the projected benefit obliga-tion.

3. General Products Company reports a liability on the balance sheet of $3,767 million at the end of Year5 because its cumulative pension expense exceeds its cumulative pension contribution.



EXHIBIT 1

GENERAL PRODUCTS COMPANYIllustrative Disclosure in Notes about PensionsExcerpts from Financial Statementsa

(all dollar amounts in millions)

Total Pension Expense for All Pension Plans for the Yearb

Year 3 Year 4 Year 5

Single-employer Defined Benefit Plans . . . . . . . . . . . . . . . . . . . . . $ 92 $107 $143

Multi-employer Plansc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 79 102

Defined Contribution Plansd . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 47 51

Total Pension Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $201 $233 $296

Expense for Defined-Benefit Pension Plans for the Yeare

Year 4 Year 5

Expense for Service during the Yearf . . . . . . . . . . . . . . . . . $ 577 $ 599

Interest Cost on Projected Benefit Obligationg . . . . . . . . . . 1,020 1,074

Actual Return on Plan Assetsh . . . . . . . . . . . . . . . . . . . . . $2,465 $2,739

Amount Deferred to Future Periodsi . . . . . . . . . . . . . . . . . . (1,430) (1,672)

Amount Reducing Current Year Expensej . . . . . . . . . . . . . . $1,035 (1,035) $1,067 (1,067)

Amortization of Excess of Market Value

of Plan Assets over Projected Benefit

Obligation on Adoption of SFAS No. 87,

Reducing Pension Expensek. . . . . . . . . . . . . . . . . . . . . (213) (213)

Amortization of Net Actuarial and Experience Gainsl . . . . . . (242) (250)

Net Pension Expense for Year. . . . . . . . . . . . . . . . . . . . . . $ 107 $ 143

Reconciliation of Projected Benefit Obligation withNet Pension Obligation for Defined-Benefit Pension Plans

December 31 Year 4 Year 5

Accumulated Benefit Obligationm

Vested Benefitsn . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11,590 $11,960

Nonvested Benefitso . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 285 298

Total Accumulated Benefit Obligation. . . . . . . . . . . . . . . . . . . . . . . . . $11,875 $12,258

Effect of Projected Compensation Increasesp . . . . . . . . . . . . . . . . . . . 2,507 2,588

Projected Benefit Obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $14,382 $14,846

Less: Current Market Value of Plan Assets. . . . . . . . . . . . . . . . . . . . . (14,915) (15,747)

Unrecognized SFAS No. 87 Transition Gain(being amortized over 15 years)q . . . . . . . . . . . . . . . . . . . . . . . . . 2,343 2,130

Other Unrecognized Net Experience Gainsr . . . . . . . . . . . . . . . . . . . . . 2,460 2,538

Excess of Pension Expense over Pension Contribution . . . . . . . . . . . . $ 4,270 $ 3,767

[Other schedules, not shown, give the market value of assets for several preceding years and the causes of the changes in those amountsfor each year.]

Exhibit 1 Author’s Notes, continued

P R O B L E M F O R S E L F - S T U D Y

Analyzing and interpreting pension plan disclosures. Exhibit 2 presents pension plan disclosures forStratadyne Corporation for Year 5 (amounts in thousands).

a. Complete the following analysis of the pension plan assets for Year 5.

PENSION PLAN ASSETS

Balance, January 1, Year 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $

Actual Return on Pension Plan Investments during Year 5. . . . . . . . . . . . . . . . . . .

Contributions Received from Stratadyne Corporation. . . . . . . . . . . . . . . . . . . . . . .

Payments to Retired Employees for Year 5 (Plug) . . . . . . . . . . . . . . . . . . . . . . . . . __________

Balance, December 31, Year 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $


Authors’ Notes (notes such as these do not usually appear in published financial statements):

aAdapted from disclosures of Anheuser-Busch, General Electric, and Inland Steel.

bThe company has several types of plans; this schedule summarizes the expenses for all of them.

cSome unions have pension plans covering employees who work for many different companies. The company contributes to the union planfor the unionized employees covered by those plans.

dThe company has defined contribution plans for some of its top-level managers who are willing to accept the risks of uncertain investmentperformance between now and the time they retire.

eOrdinarily, three years of data would appear in this schedule and the next. Only two years appear here.

f This is the service cost for benefits earned by employees during the current year. Computations take into account employees’ expectedfuture salary increases.

g Each year, the company computes the present value of benefits already earned by employees, assuming that employees will be grantedsalary increases between now and the time they retire. This amount represents the accumulation of interest during the current year on thepresent value amount, or projected benefit obligation, at the beginning of the year.

hThe company funds its pension obligations by turning cash over to an independent trustee. The trustee invests the cash and receives theinvestment earnings. This line shows the amount of earnings on the investments during the year.

i The firm cannot use all of the earnings on the preceding line to reduce pension expense in the year earned. Some earnings, such as theamount shown on this line, will reduce expense in the future.

j This line shows the amount of investment earnings reducing pension expense for the current year.

kThe SFAS No. 87 method of computing pension obligations differed from preceding pension GAAP. As a result of this and the favorablestock market experience in the years preceding the adoption of SFAS No. 87, many companies found that when they adopted the pensioncomputations, the market value of pension plan assets exceeded the present value of the pension obligations, even after they accountedfor the effect of expected future salary increases for employees. Firms can apply this excess, called the “transition gain,” to fund futurepension costs and can amortize it gradually into income. The company is amortizing the amount over 15 years on a straight-line basis. Bythe end of Year 5, the amortization period had 10 more years to run. The amounts for the current year appear on this line.

l In addition to investment earnings being recognized in income gradually, mortality experience and employee termination rates deviate fromprojections. The amount on this line, which could be positive, is the amortization of the net of these experience effects caused by actualinvestment income, mortality, and termination rates that differ from initial projections.

mAt any time, one can compute the net present value of benefits earned by employees, assuming that current salaries will not change. Thisis called the “accumulated” benefit obligation because future salary increases, although expected, have not yet occurred.

nMost pension plans require employees to work for the company for several years before they can receive the retirement benefits they haveearned during their working years. Once the employee has worked sufficiently long to be entitled to receive a benefit, that benefit is called“vested.” Until then, the benefits are called “nonvested.” Vested benefits appear on this line.

oThese are the nonvested benefits; see the preceding note.

pWhen a defined benefit plan takes the effect of expected future salary increases into account, the present value of benefits already earnedis larger than when the firm bases computations only on current and past salaries. The amounts on this line show the effect of expectedfuture salary increases on the present value of benefits already earned by current employees.

qSee note k above. This represents the amount of the excess (called transition gain) that remains to be taken into income over the remain-ing 10 years.

r See note l above. This line indicates the portion of actuarial gains and losses not yet amortized.

b. Complete the following analysis of the pension plan liabilities for Year 5.

PENSION PLAN LIABILITIES (PROJECTED BENEFIT OBLIGATION)

Balance, January 1, Year 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $

Interest Cost for Year 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Service Cost for Year 5. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Payments to Retired Employees during Year 5 . . . . . . . . . . . . . . . . . . . . . . . . . . .

Change Due to Actuarial Assumptions during Year 5 (Plug) . . . . . . . . . . . . . . . . . . __________

Balance, December 31, Year 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $

c. Did the actual return on pension fund assets exceed or fall short of expectations during Year 5? Explain.

d. What is the likely reason for the significant increase in the projected benefit obligation during Year 5 dueto actuarial assumptions?


EXHIBIT 2

STRATADYNE CORPORATIONPension Plan Disclosures(Problem for Self-Study)

January 1, December 31,Year 5 Year 5

ASSUMPTIONS

Discount Rate for Projected Benefit Obligation . . . . . . . . . . . . . . . . . 11.00% 10.25%

Increase in Compensation Levels. . . . . . . . . . . . . . . . . . . . . . . . . . . 6.10% 6.10%

Long-term Return on Pension Assets . . . . . . . . . . . . . . . . . . . . . . . . 7.50% 7.50%

FUNDED STATUS OF PENSION PLAN

Accumulated Benefit Obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 62,526 $ 82,487

Effect of Salary Increase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,232 5,341

Projected Benefit Obligation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 67,758 $ 87,828

Plan Assets at Market Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95,399 135,755

Plan Assets Exceeding Projected BenefitObligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 27,641 $ 47,927

Unrecognized Net Asset on Date ofAdoption of SFAS No. 87 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (23,469) (21,626)

Unrecognized Net Gain from PastExperience Different from Assumed. . . . . . . . . . . . . . . . . . . . . . . (3,912) (24,981)

Excess of Pension Contributions over Pension Expense . . . . . . . . . . . $ 260 $ 1,320

Pension Expense for Year 5 comprises the following:

Interest Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,453

Service Cost. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,863

Actual Return on Pension Investments . . . . . . . . . . . . . . . . . . . . . . . (39,006)

Less Difference of Actual Return in Excess of Return. . . . . . . . . . . . . 31,851

Amortization of Unrecognized Net Assets and Net Gains . . . . . . . . . . (2,270)

Net Pension Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 891

S U G G E S T E D S O L U T I O N T O P R O B L E M F O R S E L F - S T U D Y

(Stratadyne Corporation; analyzing and interpreting pension plan disclosures.) Amounts are in thousands.

a.

PENSION PLAN ASSETS

Balance, January 1, Year 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 95,399

Actual Return on Pension Plan Investments during Year 5 . . . . . . . . . . . . 39,006

Contributions Received from Stratadyne Corporation . . . . . . . . . . . . . . . . 1,951a

Payments to Retired Employees for Year 5 (Plug) . . . . . . . . . . . . . . . . . . (601)

Balance, December 31, Year 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $135,755

aPension Expense for Year 5 of $891 + Increase in Excess of Pension Contribution over Pension Expense during Year 5 of $1,060 (=$1,320 – $260).

b.

PENSION PLAN LIABILITIES (PROJECTED BENEFIT OBLIGATION)

Balance, January 1, Year 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $67,758

Interest Cost for Year 5. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,453

Service Cost for Year 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,863

Payments to Retired Employees during Year 5 . . . . . . . . . . . . . . . . . . . . (601)

Charge Due to Actuarial Assumptions during Year 5 (Plug) . . . . . . . . . . . . 10,355

Balance, December 31, Year 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $87,828

c. Actual earnings of $39,006 exceeded expected earnings by $31,851. Thus, expected earnings were$7,155.

d. The discount rate decreased from 11 percent to 10.25 percent, increasing the projected benefit obligation.Stratadyne Corporation also might have changed actuarial assumptions regarding employee turnover ormortality. Note that the increase in the projected benefit obligation does not result from a change in theassumption regarding salary increases in this case or from the excess return on pension assets.

K E Y T E R M S A N D C O N C E P T S

Pension expensePension plan assetsPension plan liabilitiesAccumulated benefit obligationProjected benefit obligationInterest costService costActual return and expected return on pension assets


P R O B L E M S

PENSIONS 1. Interpreting pension disclosures. Disclosures regarding the pension plan of Merck appearbelow for two recent years (amounts in millions).


Year 8 Year 9

PENSION EXPENSE

Service Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 65.5 $ 74.3

Interest Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97.6 110.4

Actual Return on Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52.0 (231.8)

Difference between Actual and ExpectedReturn on Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (164.0) 129.5

Amortization of Experience and Actuarial(Gains) Losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22.6 (18.1)

Net Pension Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 73.7 $ 64.3

December 31



Accumulated Benefit Obligation . . . . . . . . . . . . . . . . . . . $ 861.9 $ 967.5 $ 1,068.0

Effect of Salary Increases . . . . . . . . . . . . . . . . . . . . . . . 221.4 277.8 340.8

Projected Benefit Obligation . . . . . . . . . . . . . . . . . . . . . . $ 1,083.3 $ 1,245.3 $ 1,408.8

Plan Assets at Market Value . . . . . . . . . . . . . . . . . . . . . 1,240.6 1,136.8 1,356.1

Under (Over) funded Projected Benefit Obligation . . . . . . . $ (157.3) $ 108.5 $52.7

Unrecognized Actuarial (Gains) Losses . . . . . . . . . . . . . . 192.4 (66.5) (33.9)

Net Pension Liability on Balance Sheet . . . . . . . . . . . . . . $ 35.1 $ 42.0 $ 18.8

a. Give the journal entries to record pension expense and pension funding for Year 8.b. Give the journal entries to record pension expense and pension funding for Year 9.c. Did the return on pension assets exceed or fall short of expectations in Year 8? in Year 9? Explain.d. Suggest reasons why the portion of pension expense for amortization of experience and actuarial gains

and losses changed from a positive amount in Year 8 to a negative amount in Year 9.

PENSIONS 2. Interpreting pension disclosures. Disclosures regarding the pension plan of MayDepartment Stores at the end of two recent years appear below (amounts in millions).

January 31

Year 3 Year 4


Accumulated Benefit Obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 212 $ 208

Effect of Salary Increases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 51

Projected Benefit Obligation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 269 $ 259

Plan Assets at Market Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250 256

Underfunded Projected Benefit Obligation . . . . . . . . . . . . . . . . . . . . . . . . . . $19 $3

Unrecognized Actuarial Gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (40) (28)

Prepaid Pension Asset on Balance Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . $ (21) $ (25)

Pension expense for Year 4 was $19 million.


a. Give the journal entry to record pension expense and pension funding for Year 4.b. Why does an asset appear on the balance sheet of May Department Stores if the projected benefit obli-

gation exceeds pension assets?

PENSIONS 3. Interpreting pension disclosures. Disclosures regarding the pension plan of InternationalPaper Company for a recent year appear below (amounts in millions).

October 31

Year 4 Year 5


Accumulated Benefit Obligation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,986 $ 1,777

Effect of Salary Increases. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159 132

Projected Benefit Obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,145 $ 1,909

Plan Assets at Market Value. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,671) (2,557)

Overfunded Projected Benefit Obligation . . . . . . . . . . . . . . . . . . . . . . . . $ (526) $ (648)

Unrecognized Actuarial Gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 62

Prepaid Pension Asset on Balance Sheet. . . . . . . . . . . . . . . . . . . . . . . . $ (507) $ (586)

Pension expense for Year 5 was $77 million.

a. Give the journal entry to record pension expense and pension funding for Year 5.b. Using only the pension disclosure presented above, suggest possible reasons for the increase in

International Paper Company’s overfunded projected benefit obligation during Year 5.

PENSIONS 4. Interpreting pension disclosures. Exhibit 3 presents pension plan disclosures forAmerican Home Products for Year 6 (amounts in millions).

a. Complete the following analysis of changes in pension plan assets during Year 6.

Pension Assets, December 31, Year 5. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $

Plus Actual Return on Pension Assets during Year 6 . . . . . . . . . . . . . . . . . . . .

Plus Pension Contribution Received from American HomeProducts during Year 6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Less Pension Payments to Retired Employees during Year 6 (Plug) . . . . . . . . .

Pension Assets, December 1, Year 6. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $

b. Complete the following analysis of changes in the projected benefit obligation during Year 6.

Projected Benefit Obligation, December 31, Year 5. . . . . . . . . . . . . . . . . . . . . $

Plus Interest Cost for Year 6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Plus Service Cost for Year 6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Less Pension Payments to Retired Employees during Year 6 . . . . . . . . . . . . . .

Plus or Minus Actuarial Loss or Gain (Plug) . . . . . . . . . . . . . . . . . . . . . . . . . .

Projected Benefit Obligation, December 31, Year 6. . . . . . . . . . . . . . . . . . . . . $

c. What are the likely reasons for the sign (positive or negative) of the actuarial gain or loss related to theprojected benefit obligation during Year 6?

d. Did the performance of the pension fund exceed or fall short of expectations during Year 6? Explain.


EXHIBIT 3

AMERICAN HOME PRODUCTSPension Disclosures(Problem 4)

Year 6

NET PENSION EXPENSE

Service Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 31.5

Interest Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59.5

Actual Return on Pension Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (113.4)

Deferral of Difference between Actual andExpected Return on Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56.6

Amortization of Experience and Actuarial Gains . . . . . . . . . . . . . . . . . . . . . . . . 1.1

Net Pension Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 35.3

December 31

Year 5 Year 6


Vested Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $510.9 $620.9

Nonvested Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36.5 45.7

Accumulated Benefit Obligation (ABO) . . . . . . . . . . . . . . . . . . . . . . . . . . $547.4 $666.6

Projected Pay Increase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153.5 160.1

Projected Benefit Obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $700.9 $826.7

Plan Assets Available for Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 668.0 743.3

Underfunded Projected Benefit Obligation . . . . . . . . . . . . . . . . . . . . . . . $ 32.9 $ 83.4

Unamortized Experience and Actuarial Losses . . . . . . . . . . . . . . . . . . . . (13.4) (45.6)

Pension Liability on the Balance Sheet . . . . . . . . . . . . . . . . . . . . . . . . . $ 19.5 $ 37.8

PENSION PLAN ASSUMPTIONS

Return on Pension Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9.0% 8.5%

Discount Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.5% 7.5%

Compensation Increases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.0% 4.5%

PENSIONS 5. Interpreting pension disclosures. Exhibit 4 presents pension disclosures for Bristol-MyersSquibb for Year 8 and Year 9 (amounts in millions).

a. Complete the following analysis of changes in pension plan assets during Year 8 and Year 9.

Year 8 Year 9

Pension Assets, Beginning of Year . . . . . . . . . . . . . . . . . . . . . . . . . . . $ $

Plus Actual Return on Pension Assets during Year . . . . . . . . . . . . . . . .

Plus Contributions Received during Year . . . . . . . . . . . . . . . . . . . . . . .

Less Payments to Retired Employees during Year . . . . . . . . . . . . . . . .

Pension Assets, End of Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ $


b. Complete the following analysis of changes in the projected benefit obligation during Year 8 and Year 9.

Year 8 Year 9

Projected Benefit Obligation, Beginning of Year . . . . . . . . . . . . . . . . . . $ $

Plus Interest Cost for Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Plus Service Cost for Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Less Payments to Retired Employees for Year . . . . . . . . . . . . . . . . . . .

Plus (Minus) Actuarial Losses (Gains) for Year. . . . . . . . . . . . . . . . . . .

Projected Benefit Obligation, End of Year . . . . . . . . . . . . . . . . . . . . . . $ $

c. Did the performance of the pension fund exceed or fall short of expectations during Year 8? duringYear 9? Explain.

d. What is the likely reason for the change from an unamortized experience and actuarial gain of $76 mil-lion at the end of Year 7 to an unamortized experience and actuarial loss of $107 million at the end ofYear 8?

e. What is the likely reason for the sign (positive or negative) of the actuarial gain or loss in measuring theprojected benefit obligation for Year 9?

f. The projected benefit obligation exceeds the assets in the pension fund at the end of Year 8 and Year 9.Yet Bristol-Myers Squibb shows an asset on its balance sheet of $35 million at the end of Year 8 and $68million at the end of Year 9. Explain this apparent paradox.


EXHIBIT 4

BRISTOL-MYERS SQUIBBPension Disclosures(Problem 5)

Year 8 Year 9

COMPONENTS OF NET PENSION EXPENSE

Service Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 73 $ 82

Interest Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120 133

Actual Return on Pension Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 (335)

Deferral of Difference between Actual andExpected Return on Pension Assets . . . . . . . . . . . . . . . . . . . . . . . . . . (233) 169

Amortization of Experience and Actuarial Loss . . . . . . . . . . . . . . . . . . . . 2 7

Net Pension Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 14 $ 56

December 31



Accumulated Benefit Obligation . . . . . . . . . . . . . . . . . . . . $1,097 $1,148 $1,373

Effect of Salary Increases . . . . . . . . . . . . . . . . . . . . . . . . 310 305 357

Projected Benefit Obligation. . . . . . . . . . . . . . . . . . . . . . . $1,407 $1,453 $1,730

Pension Assets at Market Value . . . . . . . . . . . . . . . . . . . 1,511 1,381 1,694

Under (Over)funded Projected Benefit Obligation . . . . . . . . $ (104) $72 $36

Unmortized Experience and Actuarial Gains (Losses). . . . . 76 (107) (104)

Pension Asset on Balance Sheet . . . . . . . . . . . . . . . . . . . $ (28) $ (35) $ (68)

PENSION PLAN ASSUMPTIONS

Discount Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.8% 9.1% 8.6%

Compensation Increase . . . . . . . . . . . . . . . . . . . . . . . . . 5.0% 5.0% 5.0%

Long-term Rate of Return on Pension Assets . . . . . . . . . . 12.0% 12.0% 12.0%

accounting for pension plans - cengage … · accounting for pension plans learning objective...

Documents